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June’s Market Commentary is being sent out later than usual given how rapidly world events have been unfolding over the last couple of weeks.
As ever, the intention of these commentaries is to zoom out and focus on what really matters when it comes to investing over the long term while also providing some insight into the current climate and its impact on markets.
There’s commentary further down the page from our partners at Quilter Cheviot while the first part lookMarket overview – Richard Carter, Head of Fixed Interest Research
Equity markets have experienced a dramatic recovery following the biggest correction since 2022.
In just nine weeks, stocks staged one of their strongest rallies on record, while volatility, as measured by the VIX, saw its sharpest collapse ever.
Entering the year, US stocks had outperformed International stocks for over 16 years, by far the longest run of outperformance in history. But so far this year, we’re seeing the exact opposite, with International stocks up 16% vs. a 2% gain for the S&P 500.
Within International, Europe has been the standout performer with a 24% gain for the Eurozone ETF ($EZU).
The US Dollar Index is having its worst start to a year ever, which has boosted the international equity returns for US investors but had the opposite effect for non US investors with US holdings.
On the fixed income side, bonds are still working through their longest drawdown on record at nearly 5 years.
The good news: yields have risen substantially from their 2020 all-time lows, implying better forward returns for bond investors.
Commentary from Richard Carter, Quilter Cheviot
The announcement of a ceasefire between Israel and Iran has been welcomed by financial markets, marking an end to nearly two weeks of escalating conflict in the Middle East. Stock markets moved higher on Monday when the news broke, as the price of oil and gold declined.
OIL PRICE THE MAIN TRANSITION MECHANISM INTO FINANCIAL MARKETS
US strikes on Iranian nuclear facilities over the weekend caused some concern among investors, sending Brent crude oil above US$80/bbl (per barrel) after trading around US$60/bbl at the start of June. However, the market experienced its largest drop since August 2022 on Monday after it became apparent that tensions were cooling and the situation was de-escalating, with the price falling back to around US$70/bbl. An Iranian attack on America’s biggest air base in the Middle East was forewarned and no one was reported as injured or killed. The retaliation was seen as a minor aggression compared to some of the possible options — such as blockading the Strait of Hormuz — and appears to have been a face-saving parting shot rather than a ratcheting up of the conflict.
STOCKS RECOVER ON TRUCE AGREEMENT
The Middle East contributes a low single digit percentage to global GDP and of the countries in the region, only Saudi Arabia and the UAE feature in the MSCI Emerging Markets Index with4% and 1.5% weights respectively.
US stock futures opened around 1% lower on Sunday evening but ended up nearly 1% on Monday and at their highest level since February. Gold fell as the de-escalation became apparent, as investors sold out of the perceived safe-haven asset. US bond yields fell as news of the ceasefire broke, with the reduced inflation risk (due to the sizable fall in the oil price) seemingly outweighing the impact of the unwinding of flight-to-safety flows.
While recent developments are welcome, sadly, history tells us that a lasting peace may be fragile. Therefore, looking at how financial markets have reacted to previous conflicts where there has been a significant threat to energy infrastructure can provide some historical context. Although past performance is not a reliable guide to future performance, and in each instance the macroeconomic backdrop has differed, the reactions of certain assets has not always been easily assumed or predicted. In most cases, there tends to be an initial spike in energy and precious metal prices that then pares back over the subsequent weeks or months.
PAST CONFLICTS SHOW LITTLE LONG-TERM IMPACT
When Russia first invaded Ukraine in February 2022, oil prices initially spiked approximately 30% before falling back and by the end of 2022, the oil price was 20% below the pre-war level. Gold prices rose around 8% in the near term but were back to the pre-war level within a couple months and had fallen by 15% by mid-September.
A similar pattern was seen at the start of the Gulf War (Aug 1990 – Feb 1991): oil prices rose 80%, before falling to 15% – below the pre-war level – by the time of peace. Gold prices rose 11% but then fell back to the pre-war price by mid-October and were down by 3% by February 1991.
When the US and its allies invaded Iraq in March 2003 however, the pattern was somewhat different in that both oil and gold prices had seen large falls in the weeks leading up to the invasion. Oil prices had fallen nearly 30% over the week prior to the invasion before subsequently recovering somewhat by the end of 2003. The gold price fell 13% from a peak in February 2003, before falling a further 3% after the war began, before climbing by 15% by May.
PERFORMANCE POST CONFLICTS SHOWS THE NEED FOR DIVERSIFICATION
Looking at these past conflicts, it appears that while the oil price has risen in the short term, over time there is little lasting effect. While gold is seen as a hedge of geopolitical risk, its 1-month returns are not that strong and underperform US and UK stocks in two of the three instances. Longer term, US and UK stocks have outperformed gold as seen by the 12 months chart.
As with any period of increased uncertainty, it is important to remember the significance of a well-diversified portfolio, with exposure to a broad range of return drivers being the best preparation for any potential future volatility. The inclusion of alternative asset classes such as hedge funds can be beneficial in such times, especially if inflation expectations begin to rise again and government bonds do not necessarily act as a traditional safe haven.
GRAPH SHOWING 1M POST-INVASION ASSET PERFORMANCE
GRAPH SHOWING 3M POST-WAR ASSET PERFORMANCE
GRAPH SHOWING 12M POST-WAR ASSET PERFORMANCE
WEEKLY ECONOMIC ANNOUNCEMENTS:
Last week the MSCI All Country World Index (MSCI ACWI) declined 0.4% (+6.4% YTD).
UNITED STATES:
In the end, US stock indices ended last week little changed, down 0.1% (+2.1% YTD), after positive and negative news on the conflict in the Middle East. Growth shares underperformed value shares while small caps outperformed large caps. Tech stocks managed to eke out a small gain, rising 0.2% (+1.1% YTD).
The Federal Reserve meeting kept the federal funds rate at the current level of 4.25%-4.5%, as expected. This was the fourth consecutive monetary policy meeting at which the rate was left unchanged. Policymakers expect two 25 basis points (0.25%) cuts by year end, in line with their previous communication. Inflation and unemployment forecasts were revised higher while growth expectations declined.
UNITED KINGDOM:
UK stocks declined 0.8% last week (+9.6% YTD), with mid-caps broadly flat (+4.4% YTD). The Bank of England rate decision saw no change, with the base rate kept at 4.25% after a 25 basis point cut in May. There was a 6-3 split among policymakers, who hinted at a possible August cut following softening employment data.
The pound ended the week down slightly at US$1.35. The 10-year gilt yield declined 1 basis point, ending at 4.54%.
EUROPE (EX UK):
European stocks fared worse than peers last week, decreasing 1.6% (+8.3% YTD). Germany indices fell 0.7% (+17.3% YTD), French stocks declined 1.1% (+5.7% YTD) and Italian bourses declined 0.5% (+18.4% YTD).
There was a sharp rebound in the German ZEW economic sentiment index, which climbed to 47.5 from 25.2 in May, boosted by the governmental approval of a large tax relief package.
The euro ended the week around the same level it began, at US$1.15.s uses some interesting charts to provide context to the current situation.
https://www.quiltercheviot.com/news-and-events/articles/weekly-comment-markets-breathe-sigh-of-relief-on-middle-east-ceasefire/?memberurlid=2T70432609259P6380#overview